What are option greeks and how do we interpret them?

There are a number of factors that can influence the price of an option. These factors can either help or hurt option traders depending on the position they have taken. Understanding these factors is essential to be successful in the options market. 

To classify them broadly there are four Option Greeks that are popularly used. Their explanations are as under. 

Delta 

Delta is the measure of change in the option price (also known as the premium of the option) resulting from the change in the spot price of the underlying security. The value of the delta ranges from -1 to 1. Call options range from 0 to 1 whereas puts range from -1 to 0. This means that calls have a positive relationship with delta whereas puts have a negative. 

If the price of the stock rises, it would be the call buyer who would profit. Hence the price of the call option (premium) increases with the price of the underlying asset. In simpler terms, the Delta of an option helps us answer the question – “By how many points will the option premium change for every 1-point change in the underlying?” 

Gamma 

Gamma is a second-order derivative – that is, it measures the rate of change in delta over time with the change in the underlying asset price. Gamma is always positive, and its value is at its highest when the option is near the money and close to the expiry date. For example, if there are two options with the same delta value but one has a higher gamma and the other has a lower gamma. The option with the higher gamma tends to experience volatile swings and an unfavourable move in the underlying will have an oversized impact.  

Theta 

Theta is the greek that measures the change in the price of an option in response to the decay in the passage of time. The lesser time an option has to expire, the less valuable it becomes simply because there is a lesser chance of it being profitable. Time decay tends to accelerate as the expiration date of an option draws closer because there's less time left to earn a profit from the trade.

Theta is good for sellers and bad for buyers. Theta can be visualized as an hourglass - in which one side is the top side is the buyer and the bottom side the seller. The buyer must decide to exercise the option before the time runs out, but in the meanwhile, the value is flowing from the buyers to the seller's side of the hourglass. The movement is not rapid, but it's a continuous loss of value for the buyer. 

Vega 

Vega is the Greek that measures the change in the option price to changes in implied volatility. Higher volatility makes options more attractive and as a result, more expensive simply because there is a greater likelihood of hitting the strike price. As a result, Option sellers benefit from a fall in implied volatility, but it is just the reverse for option buyers.